Interest only home loans are favoured by investors who can take advantage of tax deductions and minimise the monthly repayment. This way they get the best of all worlds.
What happens is that at the end of the loan term no reduction of the principal loan amount has occurred so the original loan amount remains payable. Usually, investors who take out interest only home loans are able to sell the property after a planned number of years for much more than the original purchase price and are able to repay the loan from the proceeds of the sale.
For the time that interest only home loans have been held in an investor’s name, it is usual to 
be able to claim tax deductions for all the interest paid on the loan. When the house is sold the increased value of the property will mean that there will be a capital gains tax issue but if values are increasing at a high enough rate then investors usually do quite well.
This is why interest only home loans are sop popular with investors, especially in a market where home values are rising.
Naturally, you should always seek the professional advice of a financial adviser or accountant before you embark on any investment strategy which include interest only home loans. Remember that looking for low interest loans is still the best criterion.
When are interest only home loans the best choice?
The interest rate that applies to an investment home loan is still subject to the normal rises and falls in the market which means that you should always be sure that you can afford the loan repayments before you start out. Low rate interest loans are, of course, the better choice if you can find them.
Always bear in mind that the principal balance will always need to be repaid whenever the property is sold. Standard variable loans or even fixed rate options should be considered as part of your plan irrespective of whether you choose interest only or not.
Some home owners like to take out interest only home loans to give themselves relief from the minimum monthly payment requirement. Surprisingly, an interest only loan does not reduce the required monthly repayment by much so be careful before you exercise this option. If you have a fixed rate loan then you won’t have to worry about rises in the official cash rate set by the reserve bank and this can give you some peace of mind going forward.
Another thing to consider when considering an interest only loan as an investor is to anticipate whether or not the property will be tenanted at all times. The best plans are those that recognise there will be periods when the property remains vacant whilst a new tenant is being found. As an investor, you will still have to make the minimum monthly repayments so that should always be part of your overall financial plan.
Negative amortisation and interest only home loans are something you should discuss with your accountant or financial adviser to ensure that your interest payments are fully tax-deductible.
In the housing bubble that followed the global financial crisis many investors were caught short and forced sales contributed to the lowering of house values across the country. I suppose it is fair to say that even the best planners could not have anticipated what happened in the aftermath of the crisis but in the future the best investment plans will have a negative outlook so you can make sure you will never be caught short again.
Do Interest Only Home Loans Mean Trouble?
Now, if you decide to take out interest only home loans for even a short period of time remember that the bank will still want the full loan amount to be repaid over the original term of the loan. This is best explained through an example.
Say you take out a home loan of $300,000 over a 30 year term at an interest rate of 7%. A normal principal and interest home loan will cost $1984.33 per month. An interest only loan will reduce the repayments to $1750 per month.
If you opt for a five-year interest only period, which is usually the maximum most banks will allow, it means that the loan term will have reduced to 25 years but the principle of $300,000 remains the same. So, for the remaining 25 years of your loan the monthly repayments will be $2108.04.
It is all very well to take out an interest only loan to reduce your monthly repayment as long as you are prepared to pay the increased amount when the interest only period is over.
Remember, the total interest that is payable over the full term of any home loan has to be paid to the bank irrespective of any interest only period is that you nominate.
Some home borrowers rely on the fact that they will sell the house and move to a larger house at some stage during their life. Whilst this might be true, it doesn’t detract from the fact that the amount payable to the bank will still be the same. Interest only home loans can be dangerous!
You can see that there are some borrower benefits from taking out an interest only loan because the monthly repayments are lower but the best plan is to always pay as much as you possibly can every month to reduce the loan amount. This is the only sure fire way you can stay ahead of yourself and maximise your borrowing capacity in the future.
Whilst it is true that many borrowers can suffer financial hardship because of job loss or other changes as we saw during the global financial crisis, if you had been able to make larger repayments when times were good, the impact of things like job loss or long-term illness or injury are minimised.
Interest only home loans certainly have their place especially for investors or four borrowers who are facing a bit of a struggle. Remember that banks are obliged to give you some assistance when you are facing problems and it might just be easier to negotiate a lower rate of repayment for short-term, say for three months, before getting back on your feet. This is probably a better option than taking out an interest only loan for short-term.
In all financial matters however everyone’s circumstances are different and it is always best to consult an expert like a financial adviser or accountant before you make any of these decisions. Interest only loans can easily get out of hand the longer they go on and you don’t want to find yourself having to sell your home just to bring things back on an even keel.
Talking to mortgage broker is also a good idea because they will be able to provide you with a detailed financial analysis so you can assess the impact on your financial circumstances in both the short and medium term.
It is no surprise that the greatest impact upon your financial circumstances is not the changing interest rates will apply to home loans but the additional loans taken on through credit cards and personal loans.
When times are good it might seem like an easy option to take out an increased limit on your credit card but it is also timely to consider whether or not an adjustment your home loan could give you a better result not simply interest only home loans.
What Happens When The Interest Only Term Ends?
The options after interest only loan term ends are determined by the lender. Most interest only periods are limited to 5 years maximum, after which your loan will switch to normal principal and interest repayments for the remainder of the loan term.
If you have not used the 5 years, you may apply for an extension and see what the bank says.
Under normal circumstances though, most lenders like to see the normal principal and interest repayments resume unless you have a very good reason to keep the repayments as interest only. It might be accepted if the property is an investment property and you have an accountant who can verify this for you.
Remember that interest only home loans are normally reserved for investment properties and the bank will only extend interest only terms to owner occupied loans in unusual circumstances.
